Setting A New PACE

Upfront cost is one of the biggest challenges for commercial building owners interested in energy-efficiency upgrades and renewable-energy installations. Sure, the improvements pay for themselves over time, but commercial owners often think in terms of a two- to three-year payback period, which can limit choices to lighting replacements and other such quick fixes. Now, a new financing option is emerging that could help owners break out of short-term thinking and provide opportunities to contractors willing to do some homework researching these new plans.

Property-assessed clean energy (PACE) programs began as a way for homeowners to pay for residential solar projects. They originated in California in 2008 and soon spread to cities in Colorado and New York, providing upfront financing for photovoltaic (PV) panels and efficiency improvements that could be paid back through a property-tax assessment over a 20-year period. The plans hit a roadblock, though, when federal loan backers at Fannie Mae, Freddie Mac and the Federal Housing Finance Agency (FHFA) suggested adding such an assessment constituted an unacceptable lien on the mortgages they guaranteed.

Negotiations are continuing with U.S. housing agencies over residential PACE offerings, but they are complicated by the after-effects of the scrutiny federal loan backers faced in the wake of the recent mortgage-industry debacle. In the meantime, though, a new market is developing for commercial-building owners.

“Fannie Mae and Freddie Mac don’t play in the commercial realm,” said David Gabrielson, executive director for PACENow, a Pleasantville, N.Y., nonprofit focused on advancing PACE financing efforts across the United States. As of late April, 30 states had passed legislation enabling cities and counties to establish the kind of municipal bonds that back local efforts, Gabrielson said. He added that 14 to 16 municipal or county programs are getting ready to launch or are just below that level, in addition to existing plans in several California cities.

For local governments, PACE works like a special tax district established for road projects or sewer-system extensions. Bonds are issued and sold, with bondholders repaid by an assessment on the property’s tax bill. In this way, the building owner can use the savings accrued through reduced energy bills and/or utility payments for electricity generated by installed on-site generation equipment (such as solar panels) to repay the bondholders, without increasing their company’s debt load.

“With PACE, you don’t need any upfront money,” Gabrielson said. “It’s 100 percent project-funded, just like any municipal project, and it can be funded over the useful life of the asset, typically 20 years.”

As an additional benefit for commercial owners, Gabrielson said commercial leases may make it easier for building owners to pass tax-related assessments onto their tenants rather than, say, a rent increase to pay for central-plant improvements. Plus, because tenants typically pay their own utilities (along with a potential portion of common-area expenses), they’ll enjoy the resulting utility-bill savings an efficiency upgrade might generate.

One major difference between commercial and residential PACE offerings is the level of care required in structuring individual projects, said Derek Brown, managing director with Clean Fund, a San Francisco-based firm that helps structure commercial PACE project financing. With a residential plan financing a large number of relatively small-value projects, programs take on a one-size-fits-all approach.

“If you’re doing a residential solar installation or roof insulation, you qualify,” he said, adding that commercial efforts are more likely to focus on a much smaller number of much more expensive projects, which may run $500,000 or more.

For example, Brown pointed to a recent Clean Fund-financed project in San Francisco that is helping call attention to the PACE approach. The $1.4 million effort involved the headquarters of Prologis, the nation’s largest industrial real estate owner, on the city’s Pier 1. The vendor provided retrocommissioning services for building systems, along with upgrading lighting to light-emitting diodes and installing a 200-kilowatt PV system. Prologis has a long-term lease on the city-owned building, so a leasehold, not a deed, actually secures the transaction.

Mall owner Simon Properties also has financed three projects in California and Ohio using $2 million in PACE bonds.

Though the 20-year payment plan eases building owners’ capital outlays, the funding comes at a premium, with interest running up to 7 percent. Why such high rates in today’s low-interest environment, especially when the underlying security is so strong? Currently, there’s not enough of a market for the bonds backing PACE projects to create investor competition.

“The main challenge is building volume and having the secondary market develop,” Brown said.

He is looking to strengthen Clean Fund’s contractor relationships. He sees mutual benefit in teaming up with companies that have expertise in energy efficiency and renewable-energy installation but who may lack the financial options owners need to make such upgrades economically feasible.

“Contractors don’t have the sales people who can walk into a property owner’s office and make a finance-driven deal,” he said. Clean Fund, he added, can “come in as the financing partner with the contractor to try to help get the deal done.”